Updated July 15, 2023
What is Portfolio Rebalancing?
Portfolio rebalancing is resetting the portfolio by buying and selling the stocks to balance the weights of each portfolio. Investors can change their portfolios at their convenience.
The investors can check the portfolio related to the returns earned from each stock or the risk associated with each stock. Then the investor can make efforts to rebalance or change their portfolio.
Explanation
The investors can do portfolio rebalancing to set the portfolio weights to gain from the stocks. The investors make a suitable portfolio for themselves to earn returns, and in the future, if the price of the stocks rises or falls, the investors can reset the stocks. Suppose an investor has an asset mix of Equity and bonds. The total weight of the portfolio is 100%. If the bond market starts to decline, then the investor can think of rebalancing its portfolio weights. We allocate 40% to Equity and 60% to Bonds. Then if the market falls for the bonds, the investor can rebalance the portfolio as Equity 70% and bonds 30%. These are also dependent upon the risk and return associated with the stocks. The investors can decide their portfolio weights and change them at their convenience.
Example of Portfolio Rebalancing
For an investor with investments in Bonds, Shares, and nifty, the weights of the stocks are 10%, 40%, and 50%, respectively. The investor checked that the market is giving good returns to the shares, and the Nifty is about to fall. Now what he can do is he can rebalance the portfolio as per his preference and market conditions. He is now changing the portfolio weights by selling Nifty shares and investing more in shares to get the optimum returns. This is a simple example of portfolio rebalancing.
Costs of Portfolio Rebalancing
Investors incur costs when they engage brokers in the process of portfolio rebalancing, as it involves rearranging their portfolio and applying trading costs for any changes made. Rebalancing or rearranging the portfolio weights can be costly if done frequently because the trading expenses are levied.
Portfolio Rebalancing Strategies
Portfolio rebalancing is done to reset the portfolio weights during market fluctuations. A portfolio rebalancing strategy should be made so the investor can gain maximum profits from the portfolio. The strategy will allow the investor to change the current portfolio strategy. The investors can choose as per their convenience of portfolio stocks. The strategy helps investors to do the planning of their portfolios. The asset allocation in a portfolio is maintained to lower the risk from market fluctuation. The portfolio rebalancing strategy is implemented to help investors benefit from the transactions.
Importance of Portfolio Rebalancing
- Portfolio rebalancing prevents investors from getting risk exposure.
- It will always help the investors change their portfolios per the market demands.
- It can help the investors make an accurate decision regarding the investment.
- The portfolio rebalancing process will always guide the investors to invest in the correct portfolio to maximize returns.
- It also helps to maintain the asset block of the investors. Investors can change the alignment of the portfolio by buying and selling the stocks as per the changes in the market.
- This is also important so investors can enjoy a low risk and analyze the stock, giving more returns.
Benefits
- Investors can enjoy the opportunity of changing their portfolios or resetting their portfolios with this method.
- It will help the investors to maintain the asset block, and the stocks can be changed at the convenience of the investors and the market.
- The rebalancing will help the investors fulfill their goals, and thus it can help the investors arrange the portfolio per the risk associated with the stocks.
- It can help the investors to have risk-controlled investment proceeds.
- The rebalancing can also help avoid tax implications such as capital gain tax. The investment can be so that the investors can save taxes by wisely investing in the portfolio and resetting it.
- This can also give a comparative analysis of the stocks in the portfolio. The investors can choose from the portfolio which stock is good for them to continue and which is not.
Disadvantages
- This is a very efficient method of allocating the investors’ portfolio but also has several disadvantages.
- Investors may not be encouraged to invest for a longer period.
- The investors should also be aware that the rebalancing will incur a certain cost as trading. This can sometimes be very high, depending upon the stocks and the brokers involved.
- This constant fluctuation in the stock market can create a sense of worry for investors as they are consistently exposed to risks. So to reduce that risk, the investor will have to reset the portfolio at their convenience. This can bring some problems for the investors.
- The investors are required to gain knowledge before the investment, and also they have to be alert while deciding to change the portfolio settings; otherwise, they have to consult the brokers, and then the cost of such change will be a bit high.
Conclusion
Portfolio rebalancing is a process of resting the asset block of the investors. Investors can change the stocks in their portfolio as per their demand. The market condition can also be a guiding factor for the investors to make changes, but there are certain disadvantages, mainly associated costs. Therefore all investors should do proper research before the investment or before rebalancing.
Recommended Articles
This is a guide to Portfolio Rebalancing. Here we discuss the definition and portfolio rebalancing strategies along with their benefits and disadvantages. You may also have a look at the following articles to learn more –
